Company Perspectives:

The key to Sallie Mae's success is the vitality of the mission it serves: ensuring universal access to higher education through low cost, well-serviced student loans. Meeting the needs of its customers and its partners in the higher education and financial communities is what will drive the success of the company for the next 25 years.

Company History:

SLM Holding Corp. is the publicly-traded umbrella organization over the Student Loan Marketing Association, better known as Sallie Mae. It is the largest provider of student loan funding in the United States. The company buys student loans from originators under the Federal Family Education Loan (FFEL) program, helping to keep student loan money liquid. Sallie Mae also offers tools to college financial aid offices for dealing with loan disbursement and debt counseling, and offers privately-insured loans to borrowers. Sallie Mae is a leader in loan tracking and management technology as well. It services loans through nine regional offices in the United States. Though the company began as a quasi-public entity, with an implicit government guarantee of its loans its status changed in 1997. Sallie Mae's current debt is backed by the federal government only until 2008, when the company's government-sponsored enterprise charter expires.

Early History

Sallie Mae was created by Congress in 1972 as a publicly-owned, for-profit company. Its mission was to provide a secondary market for the exchange of federally-insured, guaranteed student loans. Congress created Sallie Mae to make student loans more liquid, and therefore give lenders a greater incentive to participate in the Guaranteed Student Loan Program (GSLP). Sallie Mae began by offering two basic services: loan purchases and warehousing advances (secured loans and lines of credit). By purchasing student loans, Sallie Mae offered lenders liquidity; the knowledge that they could sell the loans and were not required to use the money to make new student loans made lenders less nervous about tying up money in student loans in the first place. Under its warehousing program Sallie Mae lent financial institutions money to make new student loans by accepting existing loans or other government securities as collateral.

Guaranteed student loans were a special market for several reasons. The Guaranteed Student Loan Program (GSLP), created in 1965 by the Higher Education Act, was established to supplement the government's grant and work-study programs, which helped students finance higher education. Under the GSLP, the federal government assumed the risk for defaulted student loans. Originally, the government guaranteed the loans directly, but state and nonprofit agencies later directly insured the loans, backed up by federal reinsurance.

The GSLP allowed qualified students to borrow a certain amount at a special fixed interest rate each year they were in school. While students were in school and for a short grace period after they left, the federal government paid the interest on their loans, so that a student had to pay back only the principal plus the interest accrued after graduation. In addition, the government paid a special allowance to lenders to make up the difference between the low rate of interest students paid and the market rate of return. It was typically set a few percentage points above the 90-day treasury bill rate. Thus, if the borrowing rate for students was 8 percent, and the treasury bill rate was 10 percent, lenders got the 2 percent difference between that rate and the 8 percent students paid, plus 3.25 percent on top of that&mdashjusted quarterly according to the treasury bill rate.

Since collection procedures made carrying student loans costly once they reached the repayment phase, many lenders sold student loans to Sallie Mae when the student graduated. Student loans were costly not because student default rates were high (defaults were guaranteed by the government anyway), but because they were relatively small loans that required a lot of work. In addition to the federal collection and reporting requirements that had to be followed to qualify for the government guarantee in the case of default, student loans were often complicated to keep track of. For example, students had to be granted deferments for unemployment, a return to school, or any of a host of other reasons.

Sallie Mae's high volume meant that the company could administer the collection of loans with greater cost effectiveness--by 1988, Sallie Mae held 24 percent of all outstanding student loans. Thus, Sallie Mae insured an adequate supply of credit for educational needs by enabling lenders to hold onto their loans during the lucrative in-school phase, sell the loans when they began to require more attention, and use the money to make new loans.

As a federally-chartered corporation, Sallie Mae's history was shaped by legislation. After adjusting the interest rates and special allowances for GSLP borrowers and lenders for several years, in its efforts to make enough educational credit available, Congress chartered Sallie Mae in 1972 to create a secondary market for student loans. The company opened for business in 1973 with financing from Washington, D.C. banks, repaying these loans through the sale of federally-guaranteed securities the same year. After that, Sallie Mae depended on financing from the Federal Financing Bank--an arm of the Treasury Department--from which it could borrow money at very attractive rates. But Congress never intended for Sallie Mae to be government-supported, and in 1981 Sallie Mae started raising the money it needed on public capital markets. After that, it became known for its inventive financing schemes, which were designed to lock in floating-rate liabilities to match its floating-rate assets.

In 1974, Sallie Mae made its first issue of common stock, raising $24 million in capital. The sale of this stock was restricted to banks or educational institutions, who were required to buy 100 shares in order to participate in Sallie Mae's programs. This requirement was later lowered to 50 shares, and small institutions were exempt.

In 1976, the lender allowance was tied to the 90-day treasury bill rate, and its ceiling was raised from 3 percent to 5 percent. That year, in an effort to reduce the red tape and inefficiencies that often accompany federal programs, the government transferred responsibility for the GSLP to the states and encouraged them to set up their own guaranteeing agencies. It also authorized Sallie Mae to buy loans originated under a newly-created Health Education Assistance Loan Program (HEAL) to help graduate students in the health professions finance their educations.

By 1977, Sallie Mae was able to issue its first dividend. The next year, the Middle Income Assistance Act removed all income restrictions for student borrowers in response to complaints from middle-income families that they were too rich to get assistance but too poor to pay rising education costs--especially if they had more than one child in college at a time. Since students were no longer required to demonstrate financial need to qualify for loans, the program expanded rapidly--from $2 billion in new loans in 1978, to $3 billion in 1979, to $8 billion in 1980.

In 1978 Congress also removed the ceiling on the special allowance to lenders, setting the allowance simply at 3.5 percent above the 90-day treasury bill rate, so that lenders were guaranteed a market rate of return. That, and the elimination of the paperwork involved in determining eligibility, made student loans more attractive to lenders. Sallie Mae grew accordingly, from assets of $1.6 billion in 1979 to $7.5 billion in 1982.

Making Money in the 1980s

In 1980, as a prime rate near 20 percent pushed the cost of the GSLP sky-high, Congress made further amendments to the Higher Education Act. For the first time since 1968, the interest rate charged to student borrowers was raised, from 7 percent to 9 percent. It was determined that the higher rate would stay in effect as long as treasury bill rates remained at a higher level.

The rate stayed at 9 percent until 1983, when treasury bill rates fell enough to lower the rate to 8 percent. The amendments of 1980 also established a new educational lending program called PLUS, for parents of dependent students.

More important to Sallie Mae, however, were changes that increased the company's range of operations and gave it new ways of raising capital, to begin weaning it from federal support. Congress set the expiration of Sallie Mae's authority to issue federally-guaranteed obligations at 1984, but gave the secretary of the treasury power to buy as much as $1 billion of nonguaranteed Sallie Mae securities and authorized Sallie Mae to issue nonvoting common stock.

Congress also broadened the services Sallie Mae could offer, giving the company much greater flexibility in making warehousing advances by loosening the restrictions on what Sallie Mae could accept as collateral for them and by liberalizing the requirement that warehousing advances go directly back into student loans. Sallie Mae was also permitted to consolidate or refinance loans for highly indebted students; to make advances to state and other nonprofit agencies for their student loan operations; and to make loans directly to students in areas of the country where there was insufficient credit available.

In 1981, under the new Reagan administration, Congress reinstated a needs test for borrowers with a family income above $30,000. Congress also pushed Sallie Mae to lessen its reliance on federal funds more quickly. Accordingly, expiration of Sallie Mae's authority to issue federally-guaranteed obligations was moved up to 1982, and in mid-1981 Sallie Mae made its first public offering, of short-term discount notes.

Congress also continued to broaden Sallie Mae's activities, authorizing the company to deal with educational loans not insured by the GSLP and to buy and sell the obligations of state and nonprofit educational-loan agencies.

During the remainder of the 1980s, Sallie Mae experimented with ways of raising funds at as low a cost as possible. Since all of its assets--the student loans it had bought and the warehousing advances it had made--earned a floating rate of interest tied to the 90-day treasury bill rate, Sallie Mae preferred to borrow money at a floating rate tied to the same indicator. The company was very successful at doing this. With both assets and liabilities tied to the treasury bill rate, Sallie Mae was insensitive to changes in the interest rate; as a quasi-governmental agency whose assets (those same student loans) were guaranteed by the federal government, Sallie Mae was able to raise money easily, and fairly cheaply.

As the cost of education continued to outdistance inflation, student loans continued to be in heavy demand. Thus, Sallie Mae's assets grew at a breakneck pace in the 1980s: from $1.6 billion in 1979 to $28.63 billion in 1988, an increase of nearly 1,700 percent. And to Sallie Mae, which made its money on the fixed spread between its floating-rate assets and floating-rate liabilities, increased assets meant increased profits.

In April 1983, Sallie Mae made its first offering of preferred stock, and in September of that year it made its initial offering of nonvoting common stock, thus becoming a publicly-owned company.

In 1986, when Congress reauthorized the Higher Education Act of 1965, it again broadened Sallie Mae's range of operations. It also required a needs test for all loan applicants--even those with family incomes of less than $30,000--and lowered the allowance to lenders to 3.25 percent above the treasury bill rate. Sallie Mae was given the latitude to deal loans to educational institutions for physical improvements. Congress also authorized the establishment of the College Construction Loan Insurance Association (Connie Lee) to provide insurance for loans to academic institutions for facilities. Sallie Mae helped set up Connie Lee, which opened for business in 1988.

Changes in the 1990s

By the early 1990s, Sallie Mae was known as one of the most innovative borrowers around. It experimented with exotic deals such as New Zealand-dollar-denominated notes, and securities tied to the dollar-yen exchange rate. It was a consistent money-maker, and its stock flew high on Wall Street. Institutions owned three-quarters of its shares by 1991. Sallie Mae was perceived as a champion money-maker because it was the Department of Education--not Sallie Mae--that would be responsible for defaulted loans. The only way Sallie Mae could falter was if it bought loans that did not comply with federal regulations.

To avert this, the company kept very close tabs on the banks it bought loans from. It also began servicing more of its own loans. In 1990 it serviced about 40 percent of its loans in-house, and by the next year this figure had grown to almost 50 percent. This kept operational costs down, while assets continued to rise. By 1991 Sallie Mae owned a third of the $49 billion market in outstanding guaranteed student loans. And the market was expected to expand further, as tuition costs rose and more lower-income students became eligible for loans.

In spite of Sallie Mae's evident health and vitality, various government figures began to posit ways of changing the company. In April 1991 the Congressional Budget Office recommended closer government scrutiny of Sallie Mae and her government-sponsored siblings Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). Though all three of these companies were not only financially sound but actually quite profitable, the costly federal bail-out of the Savings and Loan Association made the government more cautious about entities it guaranteed. President George Bush suggested that the government might make loans directly to students, as a cost-saving measure. Sallie Mae's chief executive, Lawrence Hough, had been given a salary package worth over $2 million, and this apparently seemed wasteful to the Bush administration. However, quick criticism from many quarters brought an end to Bush's plan, and Sallie Mae seemed destined to go along its way as merrily as ever.

But Sallie Mae's bubble burst soon after. In 1993, its stock was selling at a high of $74.50, but then began a slide, landing at almost half that price two years later. Profits fell as well, as President Bill Clinton revived Bush's idea to have the government lend directly to students. The government program started up in 1994, landing about 5 percent of student loans. By the 1995-96 school year, however, the government handled about 40 percent. Clinton also asked Sallie Mae to pay new fees on loans it handled, eroding profits. The company was divided on how to proceed, precipitating a shareholder revolt.

Sallie Mae's chief operating officer, Albert Lord, resigned from his post in January 1994 over differences with CEO Hough. But in 1995 Lord organized a slate of dissidents to run for seats on Sallie Mae's board. Though both sides favored the inevitable privatization of the company, Lord's faction wanted to move faster and more aggressively, and to expand into new business areas. Hough and Lord had once been friends, but the proxy fight became bitter. Finally Hough announced that he would resign his post if his side won the board elections, hoping to appease shareholders who were critical of him personally. But Lord's side won the crucial board seats, and his Committee to Restore Value at Sallie Mae had their way.

Lord and his new management quickly implemented a reorganization plan. They set up a Delaware-chartered holding company--SLM Holding Corp.--a publicly-traded company that held Student Loan Marketing Association. Lord also moved to cut costs, both in loan acquisition and in overhead. His plan was to cut the cost of buying student loans by 50 percent over the next five years. Lord's new management also raised cash by "securitizing" a large portion of its loans. This means loans were sold to trusts, which then issued securities to back the loans.

The new corporation wanted to be able to invest in new products and services, and get out from under the instability caused by government oversight. For example, the Higher Education Act of July 1998 asked for changes in the way student loan rates were set, but it was not clear how the changes would be implemented and what the effect on Sallie Mae would be. The uncertainty of this legislation, and other legislation that might follow, made it difficult for Sallie Mae to predict its finances. Sallie Mae's new management emphasized working with congress and the president to find ways to hold costs down for students, without making student loans completely unprofitable for financial institutions. The new company hoped to have more flexibility to respond to changes, and to pursue new business as opportunities presented themselves.